Baby Steps towards the Giant Leap

Edited by Vani Rao

Alibaba files for its much-awaited IPO

Alibaba headoffice in China Source: Alibaba website.
Alibaba headoffice in China
Source: Alibaba website.

Chinese e-commerce giant Alibaba has taken the next step towards its long-awaited US initial public offering (IPO) with a preliminary F-1 filing with the US Securities and Exchange Commission (SEC) on May 6, 2014.

Tuesday’s F-1 filing gives a clearer look into a business that accounts for 80% of all Chinese e-commerce transactions and will rank among the world’s largest technology firms once it goes public.

For now, the exact size of the IPO remains closely guarded. Although many expect Alibaba to raise more than $15 billion in a public offering that may still be months away, the company used a $1-billion placeholder on its registration papers with the SEC. Alibaba also did not include details on how many shares it would be selling or its valuation in its SEC filing; though those details will be disclosed in the days leading up to the IPO.

E-commerce Powerhouse

Although it is not well-known in the US, Alibaba is an e-commerce powerhouse that sells everything from frozen fish fillets to used jetliners. Not surprisingly, Alibaba makes more money than Amazon.com Inc. and eBay Inc. combined. It has helped drive the rise of e-commerce in China, a transformation that has given millions of households greater access to clothes, books, and consumer electronics. This is in stark comparison to a major part of the Chinese population that still required ration tickets for some supermarket items in the 1980s.

Analyst estimates for the company’s post-IPO value range between $136 billion and $245 billion. If it is anywhere but at the bottom of that range, it means the company could be more valuable than Facebook Inc. (NASDAQ:FB).

Source: Alibaba's F-1 filing
Source: Alibaba’s F-1 filing

Mobile Sales Rakes in the Money

In 2013, Alibaba had 231 million active buyers and eight million active sellers. As of the end of December 2013, the company had 231 million active buyers on its site, up 44% from the previous year. Some $248 billion worth of merchandise was being sold through its site, according to the F-1 filing. For mobile, the sales totaled $37 billion. The number of monthly active mobile users in December 2013 was 136 million. Alibaba’s mobile sales accounted for 76.2% of the total mobile sales for merchandise sold in China. Moreover, Alibaba’s services represented some 76.2% of all mobile-driven purchases in China for the year ended December 2013. (It also claims that it has eight million sellers and 950,000 deliverymen.)

Alibaba’s financials compare favorably with that of Amazon.com Inc. (NASDAQ:AMZN), its closest American counterpart. Where Amazon claimed $745 million in income in 9 months of 2013, Alibaba claimed $1.73 billion, despite making just a fraction—$4.69 billion to $74.45 billion—of the revenues that Amazon claims. (It has just over half the cash on hand, with $5.2 billion to Amazon’s $9.7 billion, however.) Amazon is bigger, but Alibaba is turning a larger profit despite its much smaller revenues.

In its prospectus, Alibaba seems to keep its focus on China. The company points out that China has far less retail space per capita than the US and other wealthy European countries—0.6 square meters per person, compared with 2.6 square meters per person in the US—while at the same time, online shopping still makes up only 7.9% of Chinese consumption. And consumption in China in 2013 made up only 36.5% of gross domestic product, as compared with 66.8% in the US. China, it seems, has only just begun to shop, offering Alibaba a huge growth potential over the next few years.

Source: Alibaba/SEC F-1 form
Source: Alibaba/SEC F-1 form

At this point, the SEC will review the F-1 filing and release multiple versions of it, so it is unclear when the public will get to know the actual IPO price. The next version of the document is expected in the weeks to come.

The Yahoo Question

Alibaba’s success has provided a financial crutch for Yahoo Inc. (NASDAQ:YHOO), whose stake in the Chinese company is the main reason that its own stock price has more than doubled over the past two years.

Source: Bloomberg
Source: Bloomberg

After initially investing in 2005, Yahoo owns a 22.6% stake in Alibaba, having sold more than half its stake in the Chinese company in 2012 for more than $7 billion.  Many analysts attribute Yahoo’s recent stellar stock performance to enthusiasm over its Alibaba holdings. After its latest earnings report in April, Yahoo’s shares surged after the company’s earnings supplement showed that Alibaba’s fourth-quarter sales surged 66% and net income soared 110% year over year. Due to shareholder agreements, Alibaba can force Yahoo to sell up to 40% of its remaining stake in the company, or 208 million shares, in its forthcoming IPO.

Japan’s SoftBank Corp. is currently Alibaba’s largest shareholder with a 34.4% stake. SoftBank’s Chairman and CEO Masayoshi Son is one of four current members on Alibaba’s board, which the company eventually expects to swell to nine members.

Thus, the big question: What will Mayer buy? Or will the money go to buying back shares? As many have correctly noted, the Alibaba stake has had a significant halo effect on Yahoo’s stock and, once public, the company will have a definite value that can be counted. And, more to the point, once the Alibaba impact is felt, it will become completely clear how the core Yahoo business is valued by Wall Street—right now, hardly at all—and whether the company is worth a good deal or not.

Getting a Piece of the Pie

Right now the IPO is still only in the beginning stages and there are a lot of unknowns. It will be interesting to know that final pricing of Alibaba’s IPO. However, no matter what exchange it is eventually listed on, some hurdles may prevent average investors from laying their hands on any stock before the IPO.

There are two companies that hold large stakes in Alibaba and you can buy both of them right now. They are Yahoo, which holds close to a 24% stake, and SoftBank, which holds about 36% stake. Obviously, having a large percentage of ownership in Alibaba as these two companies have is beneficial in the long run. Already, both these stocks have already appreciated in 2013 as investors have become aware of this relationship. Buying Yahoo and/or SoftBank now is one way to possibly benefit from the Alibaba IPO, whenever it happens.

It is believed that the delay in launching the IPO may add value to it if Alibaba’s earnings continue to grow throughout 2014. The higher the eventual IPO price, the more Yahoo and SoftBank stocks will benefit in the coming months. Of course, both of those companies have their own businesses that will affect their stock price as well; hence, buying them is not a pure play on the Alibaba stock.

Less Direct Routes

There are more indirect ways to benefit from the success of the Alibaba IPO, but just as your risk is diminished, so is your reward.

The first possibility is to invest in exchange-traded funds (ETFs) or mutual funds that own a piece of either Yahoo or Softbank. On the ETF front, if you support the idea that Softbank is a better investment than Yahoo, your best bet is the SPDR S&P International Telecommunications Sector ETF, which has Softbank as its second-largest weighting at 9.42% of its $33 million net assets.

However, if you think Yahoo is the best bet, I’d go with the First Trust Dow Jones Internet Index Fund, which has Yahoo at a weighting of 4.12%.

Wait ‘n’ Buy

If you’re resigned to not gaining exposure until after the Alibaba IPO, and want to mitigate your risk, there are a couple of other possibilities. The first is to buy Renaissance IPO ETF, which adds new companies on the fifth day of trading and sells them two years later. Alibaba is sure to be added to this ETF.

The question on everyone’s mind is that what will be the impact of the IPO on the company’s status going forward. Going public should afford the Chinese giant access to new sources of capital and increase its ability to grow, both organically and, potentially, via acquisitions– something that we have seen its domestic counterpart Tencent begin to do with growing frequency. On the other hand, it remains to be seen what will be the impact of increasing regulatory scrutiny and short-term shareholder mindsets on Alibaba, which to date has had operated without much external interference.

So far, it has smooth sailing for Alibaba; even the high-growth tech world is suffering from growing investor discontent in recent times. However, once Alibaba launches its IPO, it will be anything but quiet, given the expected size of the IPO and the potential impact on the power dynamics across the tech landscape. If it is as successful as hoped, and Alibaba manages to raise more funds than Facebook’s $16 billion IPO, it will go down in history as one of tech’s largest ever IPO. That would value Alibaba at above $150 billion.

Moreover, with the ability of US investors to buy stocks of one of the biggest players in China, investable dollars that might have gone to Apple, Google and others can now flow to Alibaba more easily.

In other words, the real impact of Alibaba, which is already a behemoth in China, is yet to be felt in the US. But it’s coming.

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